China’s AIIB: Hobbled By Article 55?

The credibility of AIIB Arbitration procedures for settling disputes over Asian Infrastructure Investment Bank-funded projects could be in jeopardy if China rejects a Philippine arbitration appeal to an UN Tribunal.

Article 55 of the AIIB Articles of Agreement specifies disputes between the AIIB and a member country be submitted to arbitration by a three-member panel.

The panel is to be comprised of an AIIB bank representative, a representative of the disputing state and a third representative appointed by the International Court of Justice (ICJ).

The ICJ is the same outfit that empaneled the tribunal whose pending South China Sea ruling China says it will reject unless it wins.

In AIIB disputes, however, Article 55 specifies a majority outcome(2:1) is ‘final and binding.’

But after establishing a precedent of rejecting arbitration rulings against it (in the South China Sea) by one organ of the ICJ,China may feel emboldened to rejectAIIB arbitration decisions it doesn’t like.

This sends a powerful signal to the rest of the world about China’s view of the sanctity of contracts. It would bolster views that China –– like Russia — sees legal agreements as methods for enforcing arbitrary state power, not curbing it.

In coming years, the AIIB will extend infrastructure loans to third countries. Many of these will be made to Southeast Asian countries as part of China’s Maritime Silk Road vision.

But if China claims exceptionalism to agreed arbitration norms, others may do the same. This can create blow back consequences for China.

Take the Philippines.

In 2008, Chinese electricity infrastructure state champion State Grid Corp. of China (SGCC)won a precedent-setting contract to upgrade and operate the ramshackle Philippine electricity grid over 25 years.

By all accounts, the showcase contract has gone well. It set a precedent enabling SGCC to win subsequent contracts upgrading grids in Australia, Italy, Portugal and Brazil.

But in early 2015, amid rising tensions between the Philippines and China over China’s South China Sea territorial claims, the Philippines expelled SGCC technicians on little-documented grounds that a computer virus had infected the grid.

China’s response was instructive. Instead of claiming national exceptionalism and rejecting any dispute resolution it didn’t like, China — as a guest in the Philippines — merely meekly called for ‘procedural fairness.’ The Philippines ignored the plea.

This indicates China understands — as foreign companies do in China — the lack of recourse available for guest companies. Arbitration can help; but only if accepted as binding by both sides.

As a political single party state and recent convert to market economics, China’s export infrastructure state champions still have much to prove in the area ofcorporate governance as defined in any western sense.

Such demonstrations will be increasingly important as China’s state champions seek to export long-lived infrastructure services (among other things) to the rest of the world.

China’s creation of the AIIBto fund such exports using world-best practice is aimed at setting a positive precedent. But other precedents count as well. These include disputes submitted to arbitration panels like UNCLOS.

The Philippines — for instance — may be able to take its South China Seadispute with China to the AIIB should the AIIB make any investments in disputed areas of the South China Sea.

If China wants to realize its Maritime Silk Road concept, AIIB investments in contentious areas of the South China Sea look look unavoidable. This suggests it’s only a matter of time before a dispute within the AIIBinvolving the South China Sea arises under Article 55.

One way to avoid this would be for the AIIB — as it has pledged — to work more closely with established,credible multilateral lenders like the Asian Development Bankand World Bank.

China’s already doing this. The result could be a constructive, economically-oriented, multilaterally-accepted solution to South China Sea territorial issues.

These might be based upon creation of joint development areas that defer resolution of territorial issues indefinitely.

Asia is now the world’s fastest growing economic block. Asia will soon become the locomotive of the world economy. It’s critical such issues get hashed out. The biggest one is the validity of China’s Nine-Dotted Line.

In its dispute with the Philippines over Scarborough Shoal, which is just one territorial dispute in the South China Sea between China and her neighbors, China in 2006 declared it would not accept compulsory settlement provisions for maritime delimitation under UNCLOS.

The problem for China is that other countries may reciprocate over time in other places and in other ways. The result will be the erosion of the economic multilateralism that now underpins world prosperity.

Tens of billions of dollars of lucrative, economic-growth enhancing, quality of life improving infrastructure is needed in Southeast Asia. These range from roads, to rail systems, to telecoms, ports of and low emission energy.

The South China Sea is a big part of this. Joint development areas in the South China Sea connected to land by multilateral infrastructure will create a multiplier effect of global prosperity. Everyone will gain.

Territorialism, by contrast, is a zero, or negative sum game. Greater clarity is needed. China can provide it.

Article 55 Arbitration

If a disagreement should arise between the Bank and a country which has ceased to be a member, or between the Bank and any member after adoption of a resolution to terminate the operations of the Bank, such disagreement shall be submitted to arbitration by a tribunal of three arbitrators.

One of the arbitrators shall be appointed by the Bank, another by the country concerned, and the third, unless the parties otherwise agree, by the President of the International Court of Justice or such other authority as may have been prescribed by regulations adopted by the Board of Governors.

A majority vote of the arbitrators shall be sufficient to reach a decision which shall be final and binding upon the parties.

The third arbitrator shall be empowered to settle all questions of procedure in any case where the parties are in disagreement with respect thereto.